Understanding Tax-Loss Harvesting

In a diversified portfolio, market fluctuations are inevitable. While many investors focus on growth, a thoughtful investment approach may consider strategies designed to manage taxes through tax -loss harvesting.

What is Tax-Loss Harvesting?

Tax-loss harvesting is the practice of selling an investment that has declined in value to "realize" a capital loss. This loss may be used to offset realized capital gains which could potentially help reduce your overall federal tax liability for the year.

Potential Benefits

• Offsetting Gains: Capital losses first offset capital gains of the same type (short-term vs. long-term).

• Income Deduction: If losses exceed gains, you can typically use up to $3,000 annually ($1,500 if married filing separately) to offset your ordinary taxable income, subject to IRS rules.

• Carry-forward Provisions: Any unused losses can be carried forward indefinitely to offset gains or income in future tax years.

• Maintenance of Market Exposure: Investors my choose to reinvest the proceeds from a sale into a similar, but not "substantially identical,” security to help maintain their desired asset allocation.

Risks and Limitations

• The Wash-Sale Rule: The IRS prohibits claiming a loss if you purchase the same or a "substantially identical" security within 30 days before or after the sale. This rule applies in other accounts you or your spouse own or control, including IRAs and 401(k)s.

• Account Type Limitations: Tax-loss harvesting generally applies in taxable brokerage accounts. Tax-advantaged accounts like 401(k)s or IRAs do not generate taxable capital gains or losses, making the strategy inapplicable.

• Year-End Deadlines: All transactions must be executed and settled by the final business day of the calendar year to count toward that year's tax return.

Case Study Example

Consider an investor who sells an investment for a $15,000 realized gain, which could trigger a significant capital gains tax bill. To mitigate this, they "harvest" a $10,000 loss by selling a different, underperforming investment, reducing their net taxable gain to just $5,000.

If that same investor instead realized a $20,000 loss, they would completely wipe out the $15,000 gain and could use $3,000 of the remaining loss to offset their ordinary income (like salary), while carrying forward the other $2,000 to future years. To remain compliant with the Wash-Sale Rule, the investor would reinvest the proceeds into a different fund with similar market exposure rather than buying back the exact same security within 30 days.

*This hypothetical example is for illustration purposes only and does not represent any

particular investment.

Is tax-loss harvesting right for you?

While tax-loss harvesting can be a valuable tool for managing your tax burden, it should remain secondary to a disciplined investment approach. It is important to remember that this strategy does not guarantee higher returns or protection against market declines, and it should never be the sole motivation behind a trade. Ultimately, harvesting losses is most effective when integrated into a comprehensive financial plan that prioritizes your specific long-term goals and broader asset allocation. This strategy is not suitable for every investor. Please consult with your investment or tax advisor.

John P. Freund is registered with and securities are offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Suite 1201, Ft. Lauderdale, FL 33308 (954) 782-4771 Investment Advisory services are offered through Kovack Advisors, Inc. Naples Financial Solutions, LLC is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc.

Naples Financial Solutions does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Naples Financial Solutions cannot guarantee that the information herein is accurate, complete, or timely. Naples Financial Solutions makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money. Asset allocations and diversification cannot guarantee profit or insure against a loss. There is no guarantee that any investment strategy will be successful; all investing involves risk, including the possible loss of principal.